The economist intelligence unit all that glitters 2016

On that day, the International Atomic Energy Agency IAEA judged that Iran was fully compliant with its internationally agreed nuclear obligations—a ruling that in effect restored the Isl

A report by The Economist Intelligence Unit

sanctions Iran

January 16th 2016 will forever be viewed as a watershed for Iran On that day, the International Atomic Energy Agency (IAEA) judged that Iran was fully compliant with its internationally agreed nuclear obligations—a ruling that in effect restored the Islamic Republic to the global community of nations and removed a mass of international sanctions that had been piled on the country since 2006 Keen

to make up for lost time, Iran’s president, Hassan Rowhani, has been urgently seeking to drum up new business On January 23rd he hosted a summit for China’s president, Xi Jinping, in Tehran, at which the two sides agreed to boost bilateral trade to US$600bn within a decade This was swiftly followed by a trip to Italy and France, where some €50bn (US$55bn) in contracts were signed

However, even with Iran’s doors thrown open, it would be wise for businesses to keep in mind the ancient Persian proverb: “He who wants a rose must respect the thorn” Iran’s economy is unusual among the region’s oil exporters; it boasts the largest natural gas reserves in the world and the fourth-biggest oil reserves, and yet it has a diversiied economy (including a signiicant manufacturing sector), all backed up by a large, youthful, well-educated and welcoming population But the business climate is less welcoming Vested interests still permeate almost every aspect of the economy, typically operate outside the parameters of international commercial law—especially those businesses connected to the Islamic Revolutionary Guards Corps—and will jealously guard the gains they accrued during a decade of sanctions And the inger of blame for Iran’s tricky operating environment should not be pointed solely at Iran; an array of residual US sanctions can snare the more unwitting investor, and Iran’s economic momentum is still too dependent on the vagaries of the global oil market

In this white paper The Economist Intelligence Unit will sketch out an economic road map of Iran’s future, outlining the most promising economic sectors within the world’s most exciting emerging market, but also detailing the country’s regulatory impediments to business We will also provide lessons from the past, and reveal where Iran sits among the world’s major economies in our business environment rankings

Introduction

Since 1979 Iran’s economy has been buffeted by the chaos of the post-revolutionary environment

and the demands of the eight-year war with Iraq (1980-88), and more recently by international

isolation, luctuating oil prices, sanctions and a ierce power struggle within the country’s political

institutions As a result, economic policymaking has been haphazard for much of the

post-revolutionary period; no consistent strategy towards economic development has been pursued, and

the commitments of successive ive-year plans to support market-oriented reforms, boost the role

of the private sector and diversify the economy away from its reliance on oil exports have not been

rate, relaxed import restrictions, launched a conservative privatisation drive and established an oil stabilisation fund (OSF) However, all the gains that were made during these years were largely squandered during the presidency of Mahmoud Ahmadinejad (2005-13), whose highly divisive presidency saw huge cash pay-outs and massive social housing programmes directed at the country’s poor, but also rocketing inlation, a collapse of the exchange rate and the depletion of the country’s OSF It was also during his presidency that Iran’s efforts to establish a civil nuclear programme with international acquiescence were abandoned and a more nationalistic and confrontational approach to the nuclear issue was adopted

The consequent swathe of international sanctions led to the halving of Iran’s oil exports and the country’s inancial sector being almost entirely cut off from the rest of the world Not surprisingly, amid the tanking economy, the public yearned for change—culminating in the thumping presidential election victory for a moderate cleric, Hassan Rowhani, in the 2013 presidential election on a simple promise of diplomacy, dialogue and, ultimately, the ending of sanctions

Rowhani inds a receptive audience in the White House

With a receptive audience in the shape of the US president, Barack Obama, talks made rapid progress, and an interim agreement was signed in November 2013 that provided for a halting of new sanctions and the release to Iran of over US$4bn in frozen funds However, the short-term boost this provided

to the economy soon dissipated as oil prices began their long downward lurch from September 2014, causing the Iranian delegation to redouble its efforts to reach a inal deal Eventually, after numerous postponements, on July 14th 2015 a inal agreement was reached, the Joint Comprehensive Plan of Action (JCPOA) The JCPOA immediately provoked outcries from hardliners on all sides, with Iranian conservatives decrying the neutering of the country’s nuclear programme and the perceived violation

of Iran’s sovereignty; in the West, meanwhile, Republicans in the US banded with Israel to denounce the deal as being too favourable to Iran, arguing that Iran could not be trusted to keep its side of the deal

Yet despite the scepticism, on January 16th the IAEA conirmed that Iran had implemented its commitments, including the shipment of 11 tonnes of Iran’s enriched uranium to Russia in late December, followed in early January by the redesign of its Arak heavy-water reactor With the onset of

“Implementation Day”, the sanctions that had hobbled the economy for a decade were inally lifted

Timeline of sanctions

August 2006

The UN Security Council passes Resolution 1696,

which threatens economic sanctions against Iran,

after the Islamic Republic fails to respond deinitively

to a compromise from the P5+1 (the ive permanent

members of the Security Council plus Germany)

allowing it to conduct part of the nuclear fuel cycle

in-country, in return for re-suspending uranium

enrichment

December 2006

The Security Council passes Resolution 1737

introducing limited sanctions

March 2007

A second round of sanctions is agreed by the Security

Council following a unanimous vote in support of

Resolution 1747, which seeks to block Iranian arms

exports and to tighten sanctions against Iran’s

nuclear industry

March 2008

The Security Council passes Resolution 1803, which

includes an outright travel ban on Iranian oficials

engaged in Iran’s nuclear and missile programmes

September 2009

The US president, Barack Obama, reveals that Iran

has been building a nuclear facility in the side of a

mountain in Qom Iran counters that it had informed

the International Atomic Energy Agency (IAEA) of the

plant a week before

June 2010

The Security Council passes Resolution 1929, which

freezes the assets of the Islamic Revolutionary Guards Corps and Islamic Republic of Iran Shipping Lines, recommends that states inspect Iranian cargo and imposes inancial restrictions on individuals and entities connected with Iran’s nuclear and missile programmes

January 2012

The EU introduces a phased ban on imports of Iranian oil, and, under pressure from the US, several Asian countries agree to reduce their imports of Iranian crude Subsequently, Iran is cut off from the Society for Worldwide Interbank Financial Telecommunication network

November 2013

Iran and the P5+1 agree to the Joint Plan of Action, allowing for a partial freezing of Iran’s nuclear programme in return for an easing of sanctions on Iran’s automotive and air sectors and the unfreezing

of funds held abroad

July 2015

The Joint Comprehensive Plan of Action (JCPOA) is signed between Iran and the P5+1 Iran agrees to limit the capacity of its nuclear programme, meeting

US demands for a minimum “breakout time”—the time it would take Iran to produce enough weapons-grade uranium for a single nuclear weapon—of a year

or more and a tighter inspection regime by the IAEA

In return, all nuclear-related sanctions will be lifted, once Iran abides by its requirements

January 2016

“Implementation Day” The IAEA conirms that Iran has met its obligations under the JCPOA and sanctions are lifted

to rise by around 700,000 barrels/day (b/d) by the end of 2016 There will be further increases in

2017-20, but the size of these will depend in part on whether Iran can persuade technologically advanced international companies to invest in the sector (An agreement with Total in January under which the French energy giant will explore development and exploration opportunities in Iran offers some early encouragement.) Investment in Iran’s underexploited natural gas reserves, in particular, could increase dramatically

The lifting of sanctions on the inancial sector—which will see Iran’s reincorporation into the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network—will help to ease general trading and investment conditions, and will therefore provide a big boost to Iran’s sizeable non-oil sectors With rising inward investment and an improvement in the public inances, private consumption will also strengthen (as will import growth)

Overall, given Iran’s hydrocarbons wealth, demographics and economic diversity, the comprehensive nuclear deal could herald a return to trend real GDP growth rates of around 5%

However, growth will remain below potential given the challenging business environment and the ongoing slump in oil prices (which will prevent any post-sanctions budget giveaways) Equally, the positive outlook all depends upon the Joint Comprehensive Plan of Action sticking; the provision for

a “snap-back” of sanctions should Iran renege on its commitments will remain a persistent risk to this brighter outlook for some years to come

Exchange rate and inlation

Years of iscal incontinence during the presidency of Mahmoud Ahmadinejad (2005-13), followed

by the 50% devaluation of the Iranian rial in 2013, drove a surge in Iranian inlation, which peaked

at 45% in mid-2013 However, with the administration of Hassan Rowhani restoring iscal prudence

and global commodity prices slumping, consumer price growth fell to a ive-year low in 2015 We

expect consumer price inlation to fall further, to 12.5% in 2016, as the onset of sanctions relief eases

bottlenecks and services costs (insurance) on imports moderate—a trend that will allow average

consumer price inlation to drop below 12% in the latter part of our 2016-20 forecast period Falling

inlationary pressures will be supported by a more stable exchange rate, including a narrowing of the

gap between the oficial and the black-market rates (the latter of which is currently about

IR35,000-37,000:US$1), as the lifting of sanctions and the subsequent uptick in inward investment boost

conidence in the rial The ability of Bank Markazi (the central bank) to manage the exchange rate

should improve as it gains access to foreign reserves currently frozen abroad

Forecast summary

(% unless otherwise indicated)

2015 a 2016 b 2017 b 2018 b 2019 b 2020 b

Crude oil production (‘000 b/d) 2,862 3,349 3,426 3,529 3,620 3,801

Oil exports (US$ m) 41,615 48,672 63,749 73,540 75,304 78,720

Consumer price inlation (av) 13.7 c 12.5 12.9 12 11.5 11.5

Consumer price inlation (end-period) 9.4 c 12.7 12.5 11.8 11.5 12

Oficial net budget balance (% of GDP) -3.5 -2.9 -2.7 -3.1 -3.5 -3.8

Exchange rate IR:US$ (av) 29,011 c 31,187 33,059 34,877 38,016 41,095

Exchange rate IR:US$ (end-period) 30,130 c 33,032 35,537 37,986 41,125 44,204

Exchange rate IR:¥100 (av) 23,762 c 25,075 26,877 28,588 31,680 34,795

Exchange rate IR:€ (end-period) 32,239 c 35,840 41,045 45,013 49,761 53,929

a Economist Intelligence Unit estimates b Economist Intelligence Unit forecasts c Actual.

Energy sector

Introduction

Until a raft of US and EU sanctions on Iran’s oil and gas sector was imposed in 2012—as part of an effort to curb the Islamic Republic’s nuclear programme—Iran had long been OPEC’s second-largest oil producer Iran was producing 3.6m barrels/day (b/d), of which 2.3m b/d was exported, just prior

to the imposition of those sanctions By the time “Implementation Day” occurred on January 16th—the day nuclear-related sanctions were lifted—Iran had been overtaken by Iraq as the number two producer in OPEC, with its oil production falling to 2.9m b/d and its exports more than halving to 1.1m b/d

Iran is now set, however, to witness a major recovery in its oil and gas sector in a post-sanctions environment In addition to restoring oil production and exports to pre-sanctions levels in the short term, Iran also hopes to attract signiicant foreign investment in the long term, of tens of billions of dollars, in order to boost oil production to nearly 6m b/d in ive years Besides oil, Iran is also seeking

to exploit its hugely underexploited natural gas reserves in order to become a major global exporter of natural gas as well

Iran will struggle to reach its longer-term production targets

The Economist Intelligence Unit considers it entirely realistic for Iran to return to pre-sanctions production levels of 3.6m-3.7m b/d; however, its goal of reaching output of 5.7m b/d—a production level not achieved since before the 1979 revolution—will not be realised until well into the future, if ever Nonetheless, sanctions on energy investment in Iranian oil and gas have been lifted (apart from some US prohibitions, which have been kept in place), and Iran will be able to export crude oil to all customers (except the US) without restriction, resuming sales to the EU and increasing sales to Asia Low oil prices and a supply glut make the timing of Iran’s return to the oil market dificult, but it can be expected that production and exports will be able to creep up to pre-sanctions levels

Iran is also a major natural gas producer, although it mostly supplies the large domestic market With additional investment Iran could become a more signiicant exporter of natural gas, especially given its huge resource base, although this is likely initially to be restricted to supplying nearby

Sectoral analysis

Iran oil production

('000 b/d)

(a) Estimate (b) Forecast.

Source: The Economist Intelligence Unit.

20(b) 19(b) 18(b) 17(b) 16(b) 15(a) 14 13 12 11 10 09 08 07 06 05 04 03 02

20(b) 19(b) 18(b) 17(b) 16(b) 15(a) 14 13 12 11 10 09 08 07 06 05 04 03 02

01

2000

(a) Estimate (b) Forecast.

commitment to limit its nuclear activities as outlined in the Joint Comprehensive Plan of Action is vital,

as failure to do so would result in energy sanctions being reimposed, or “snapped back” Another key factor will be Iran’s domestic business environment and its ability to attract foreign investment

Iranian oil exports

With Implementation Day completed, Iran will resume oil exports to EU buyers Iran was exporting 600,000-700,000 b/d before the EU imposed a ban on Iranian oil imports in early 2012 Iran will also

be able to export oil to other markets, such as China, Japan, South Korea, India and South Africa, without restriction Some US and EU sanctions were aimed at discouraging non-EU customers from buying Iranian oil, such as preventing them from insuring tanker deliveries or paying Iran for oil through the international inancial system What has not changed, however, is the US ban on Iranian oil imports, which has been in place since the 1980s

Iran aims to boost output by 1m b/d within 12 months

Iran has said that it will boost output by 500,000 b/d now that sanctions have been lifted and, more optimistically, that it will increase output by a further 500,000 b/d six months after that

However, with the oil market well-supplied and weaker demand growth expected this year, the global environment is hardly ideal for Iran’s attempts to regain market share With this in mind, Iran is likely

to offer very competitive pricing, as well as crude for product swaps or deferred payments to encourage further sales At any rate Iran is unlikely to lood the market and risk contributing unnecessarily to

a prolonged period of depressed prices; the process of lifting Iran’s oil output will therefore almost certainly be gradual

Iran has also placed tens of millions of barrels of crude oil and condensates in storage, because its ability to sell oil under sanctions was curtailed According to Platts, an energy information provider, Iran could be holding anywhere between 30m and 50m barrels of condensates and 10m-15m barrels of crude oil Iran will focus on ofloading its condensates and crude oil from storage in vessels in the Gulf,

if for no other reason than to make additional vessels in its tanker leet available for greater levels of crude oil deliveries

Iranian energy investment

Given its substantial reserves of oil and gas, Iran has the potential to be a much greater player in global energy markets Iran has 157bn barrels of oil in proven reserves (the fourth-largest in the world) and 1,201trn cu ft of proven reserves of natural gas (by some measurements the largest in the world) Iran produced over 6m b/d of oil in the mid-1970s, but since the revolution its crude production has been affected by conlict, sanctions and economic isolation Iran is also a major natural gas producer, but the vast majority of its gas output is focused on supplying the domestic market (Iran is the fourth-largest gas consuming economy) Only small volumes of gas are exported via pipeline to neighbouring Turkey and Armenia (although Iran plans to export gas to Iraq, Pakistan and eventually Oman) On paper Iran, with its substantial resource base, is a potentially bright prospect for energy investment, but the extent to which the country is able to capitalise on this will depend on its ability to attract the necessary investment